Tariffs and Schrodinger's Cat

There may be some internal pushback in the White House, though I fear it won't matter. If I'm right, stagflation is looking increasingly likely.

In a WaPo article on the forthcoming tariff storm, I saw a line that struck me as significant in a way you might have missed if you haven’t been part of a White House team. Let me set it up for you.

The piece features Trump’s id-adviser Peter Navarro claiming that, like Schrödinger's cat, tariffs will both raise an unprecedented, even scary (explained in a moment) amount of revenues for the U.S. Treasury, yet “…tariffs are tax cuts.”

In fact, tariffs are tax increases, which is interesting in a way that came up in Fox News interview I recently did. Liz Claman and I were having a back-and-forth (imho, a good, substantive one) re the fiscal outlook and I pointed out that any plan to get to sustainability will surely have to include both tax increases and spending cuts. She countered that I must know that Republicans would never raise taxes.

But, I responded, they are doing just that! Moreover, they’re doing so aggressively and without a peep of resistance from Republicans. Not a murmur! To the contrary. And if you read Navarro in the WaPo, the tariff-tax increase raises $600 billion per year ($6 trillion over 10 years), which is ~1.5 times the revenues lost from the Trump tax cut extension! [In the original post, I mistakenly said $600bn/10.]

It’s a nonsense number that no-one should take seriously. Everyone knows that tariffs are a tax (on imports). I’ve seen scores between $1-2 trillion over ten, so they can potentially raise real revs, but, as I point out to Ms. Claman, they’re taxes on the wrong people. Low-cost imports are a larger part of the market basket of middle- and low-income households. Tariffs are a regressive tax.

Readers here know that I’ve long craved more revenues. While current revs/GDP are around their historical average of around 17%, given that the economy has been around full employment with strong GDP growth and high profitability for years, we should be looking at rev shares closer to that 20% peak in 2000. Decades of tax cuts, mostly at the high-end of the income scale, have severely damaged the link between strong economic growth and revenues flows.

So why did I call Navarro’s $600 billion/yr “scary.” Not solely because tariffs are regressive but because of what Jessica Riedl says in the article:

We’ve never seen a president propose such a drastic tax increase at a time where there is no national emergency requiring it” and the economy is already slowing, Riedl said. “You just do not hear numbers like $6 trillion over 10 years in legislation or executive orders.”

The point is that a tax increase of that magnitude would be way too contractionary and tank the economy.

But enough about fantasy numbers. The serious research that caught my attention this weekend was a new forecast from the Goldman Sachs (GS) macro team, which I follow closely as they’ve been ahead of the crowd in accurately forecasting stronger growth and downplaying recession worries in ‘22-‘23. In advance of “Liberation Day,”—this Wednesday when the next tranche of tariffs will be announced—they’ve taken the real GDP growth forecast for Q1 down to 0.2%. They raised their forecast for core PCE inflation for this year by 0.5% to 3.5% and their unemployment rate forecast by 0.3% to 4.5% “at end-2025 to reflect weaker GDP growth and the effects of federal spending cuts and layoffs. We raised our 12-month recession probability from 20% to 35%, reflecting our lower growth forecast, falling confidence, and statements from White House officials indicating willingness to tolerate economic pain.”

In other words, stagflation: slower growth, higher prices.

Okay, that’s all the setup for the inside baseball I referenced above. When asked what consumers, businesses, investors should expect on Wednesday, Kevin Hassett, the White House’s NEC director, said:

“I can’t give you any forward-looking guidance on what’s going to happen this week,” said Hassett, who is widely regarded as more skeptical of tariffs than Navarro. “The president has got a heck of a lot of analysis before him, and he’s going to make the right choice, I’m sure.”

This signals an internal disagreement, which, if I’m right, is exactly what you’d want to hear right now, and good for Kevin for having the courage to push back, if that’s what he’s doing. My guess would be he’s not saying don’t go there but arguing for more gradual implementation.

Along with the rest of us, I’m a lot less sure the president is going to make the right choice. I fully expect him to make the wrong one and, like I said, those GS folks have a good track record. If they’re right, the only liberation we’ll get from Liberation Day will be the U.S. economy’s liberation from the ongoing economic expansion the Trump administration inherited, along with consumers’ liberation from paying lower prices on imports.